Case Concerning Volume-based Costing Versus Activity-Based Costing:
Coffee Bean Inc. (CBI) processes and distributes a variety of coffee. CBI buys coffee beans from around the world and roasts, the blends, and packages them for resale. Currently the firm offers 15 coffees to gourmet shops in 1 pound bags. The major cost is direct materials; however, a substantial amount of factory overhead is incurred in the predominantly automated roasting and packaging process. The company uses relatively little direct labor.
Some of the coffees are very popular and sell in large volumes; a few of the newer blends have very low volumes. CBI prices its coffee at full product cost, including allocated overhead, plus a markup of 30%. If its prices for certain coffees are significantly higher than the market, CBI lowers its prices. The company competes primarily on the quality of its products, but customers are price conscious as well.
Data for the 2012 budget include factory overhead of $3 million dollars which has been allocated by its current costing system on the basis of each product's direct labor cost. The budgeted direct labor cost for 2012 totals $600,000. The firm budgeted $6 million for purchases and use of direct materials (mostly coffee beans).
The budgeted direct labor costs for 1 pound bags of two of the company's products are as follows:
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Mona Loa
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Malaysian
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Direct materials
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$4.20
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$3.20
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Direct labor
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0.30
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0.30
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CBI's controller, Mona Clinton, believes that its current product costing system could be providing misleading cost information. She has developed the analysis of the 2012 budgeted factory overhead costs:
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Activity
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Cost driver
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Budgeted activity
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Budgeted costs
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Purchasing
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Purchase orders
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1,158
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$579,000
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Materials handling
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Setups
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1,800
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720,000
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Quality control
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Batches
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720
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144,000
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Roasting
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Roasting hours
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96,100
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961,000
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Blending
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Blending hours
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33,600
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336,000
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Packaging
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Packaging hours
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26,000
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260,000
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Total Factory Overhead Cost
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$3,000,000
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Data regarding the 2012 production of two of its lines, Mona Loa and Malaysian, follow. There is no beginning or ending direct materials inventory for either of these coffees.
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Mona Loa
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Malaysian
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Budgeted sales
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100,000
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Pounds
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2,000
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Pounds
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Batch size
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10,000
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Pounds
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500
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Pounds
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Setups
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3
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Per batch
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3
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Per batch
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Purchase order size
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25,000
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Pounds
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500
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Pounds
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Roasting time
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1
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Hour per 100 pounds
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1
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Hour per 100 pounds
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Blending time
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0.5
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Hour per 100 pounds
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0.5
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Hour per 100 pounds
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Packaging time
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0.1
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Hour per 100 pounds
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0.1
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Hour per 100 pounds
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Required:
1. Using Coffee Bean Inc.'s current product costing system,
a. Determine the company's predetermined overhead rate using the direct labor cost as the single cost driver.
b. Determine the full product costs and selling prices of 1 pound of Mona Loa coffee and 1 pound the Malaysian coffee using the above single cost driver.
2. Using an activity based costing approach, develop a new product cost for 1 pound of Mona Loa coffee and 1 pound of Malaysian coffee. Allocate all overhead costs to the 100,000 pounds of Mona Loa and the 2,000 pounds of Malaysian. Compare the results with those in requirement 1.
3. What are the implications of activity-based costing system with respect to CBI's pricing and product mix strategies? How does ABC add to CBI's competitive advantage?